champpixs
Back in the spring, we outlined a successful trade on The Cheesecake Factory (NASDAQ:CAKE) that approached just about to our exit levels for 20% gains. After exiting that position in late July we were recently asked about our current position on the stock as it is down over 25% in two months. Here is the thing folks, it is not the company or the stock alone. This is for the most part a sector wide smackdown. Consumer discretionary names, in particular niche restaurant operators, as well as a lot of specialty retail, have corrected sharply in the last two months, far outpacing the broader market’s declines. Why? In our opinion, these stocks have priced in the risk of student loans returning which will reduce consumer spend, a deterioration in the labor market that is brewing, and in some cases, have priced in a mild recession. The thing is, operationally, nothing has really changed. Sales continue to hold up, and earnings are strong. Commodity inflation has eased, while wage inflation has persisted. To be sure, Cheesecake Factory has passed much of the costs onto the consumer. While macro pressures have built, the risk is largely priced into shares in our opinion. We think that you can start buying in the mid-$20 range. Below we outline another trade following the 25%-plus decline in shares in two months.
The play
- Target entry 1: $27.95-28.20 (30% of position)
- Target entry 2: $26.00-$26.25 (33% of position)
- Target entry 3: $24.50-24.75 (37% of position)
- Target exit: $30 if one lot, $29 if two lots, $27.50 if all 3 lots
- Stop loss: $21
- Options considerations (we like a put selling approach on the recent VIX spike, specific strikes and time frame suggestions are reserved for our Investing Group members)
Note: This type of trade is what we lay out for members week to week.
Discussion
The Cheesecake Factory saw mixed results for Q2, but we think the outlook going forward remains strong especially with this revaluation in shares. At the levels above, The Cheesecake Factory stock is a value play, and frankly is starting to offer income on pace with many REITs, as the yield approaches 4%. Sure that is less than you can get on cash or bonds, but is a nice bonus while you wait for a rebound. We issue a buy rating despite some pressure on comps, and some signs of a slowdown. However, barring a moderate to strong recession, growth is projected through 2025 on earnings. Further, on top of the dividend, The Cheesecake Factory is also buying back shares. We think a mild recession will have minimal impact. Further, as we always say, people need to eat, and while that does not necessarily mean at a restaurant, the target clientele of this company in our opinion is the middle and upper middle class, relative to lower cost competition. Despite softening, the jobs data is just so strong still and consumer confidence has largely held up. More importantly The Cheesecake Factory’s performance has held up, and the outlook is favorable, especially considering the big decline in performance. Let us discuss the reported Q2.
Revenues rise and comparable sales are positive
One key metric we look for in restaurants is the growth in comparable sales. For Cheesecake Factory, revenues rose in Q2 versus the prior year’s second quarter. The Cheesecake Factory registered revenue of $866.1 million in Q2 2023, up 4% year-over-year and flat from the sequential Q1. However, as we said, the quarter was mixed, given this increase in sales from last year was actually a miss of $13.7 million versus consensus estimates. With that said, the comparable sales results rose. The Cheesecake Factory saw positive comparable store restaurant sales of 1.5% over last year and rose 14% from the pre-COVID year 2019 comparable quarter. In terms of margins, cost and expenses were 94.5% of sales down from 96.6% last year, a sizable improvement for margins. Food inflation and wage inflation have been key risks. That said, food and beverage costs came in at 23.2% of sales down from the 24.5% last year. Labor expenses fell too as a percent of sales to 35.3% of sales which was down from 36.6% last year.
Earnings growth
Margins are improving. Food inflation is declining while labor inflation is ongoing but fell as a percent of sales. Putting together revenue and expenses we saw adjusted EPS of $0.88 was a nice beat of $0.06 against estimates and rose from $0.52 from Q2 2022. Through the first half of the year, EPS is up 50% to $1.50, from $0.99 compared to H1 2022. This is outstanding. We believe shares are undervalued especially combined with the forward view.
Valuation attractive
The valuation is attractive based on performance numbers we are expecting. We are trading at about 10X FWD earnings. And we expect slow stable growth as the company continues to be rather strategic in opening new shops, while margins are improving. Further, the dividend offers a 3.8% dividend yield. We expect dividend increases moving forward after being suspended for two years for the pandemic. Further, the company is still repurchasing shares. The Cheesecake Factory bought back 280,400 shares of stock for $9.3 million, further boosting shareholder value.
Forward view
Folks, the sector has been crushed. Many restaurant stocks have been battered, no pun intended. The balance sheet is healthy while the debt is quite manageable relative to cash flows. At the end of Q2 The Cheesecake Factory had total available liquidity of $330.1 million. This includes a cash balance of $91.6 million and availability on its revolving credit facility of $238.5 million. Total principal amount of debt outstanding was $475 million, including $345 million in principal amount of 0.375% convertible senior notes due 2026 and $130 million in principal amount drawn on the revolving credit facility. This is manageable. As we look ahead for the year, we now see EPS of $2.75-$3.00. This translates to about 10X FWD earnings. This is a great price, considering earnings for the year will nearly double at our midpoint expectation.
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